Dollar Has Room to Run after Biggest Two-Day Rally in Two Months

• Dollar Has Room to Run after Biggest Two-Day Rally in Two Months
• Euro Tumbles Across the Board but EURUSD 1.3000 Primary Focus
• Japanese Yen: BoJ Adds Stimulus Cross Offer Slow Reaction
• Australian Dollar Continues its Retreat with Others Falling in Line
• British Pound Risks Reversal Below 1.6200 with BoE Minutes on Deck
• New Zealand Dollar 2Q GDP on Deck after Key Says Government Can’t Hold Kiwi Down
• Gold Range Bound for Third Day, Breaking 1775 Requires Stimulus and 1750 Risk Trends

Dollar Has Room to Run after Biggest Two-Day Rally in Two Months

Though EURUSD posted a hefty correction (0.5 percent) this past session, the US dollar is not yet diving into a bullish reversal. Critically absent from the market is a strong conviction on underlying risk appetite that is both restraining the sentiment-favored assets (S&P 500 from progressing beyond 1475) as well the safe havens (keeping EURUSD’s 1.3000 figure tantalizingly out of reach). That significantly undermines the confidence drawn out of the greenbacks’ two-day rebound through Tuesday. The Dow Jones FXCM Dollar Index’s (ticker = USDollar) back-to-back climb may simply be a necessary correction following the sharpest decline for the benchmark since last November. The difference between a motivated trend change and low-participation retracement is the level of intensity and follow through. At the current pace and fundamental depth, the Dollar Index will struggle tremendously to maintain its bearings – much less drive return to the key 10,000 figure.

We are still missing a vital puzzle piece to this bigger market picture: participation. Though it is easier to generate volatility when there are few traders in the market, central bank stimulus has a greater dampening effect as well. To return to true, market-derived trends; we need to see the global ranks fill out to commit to build up or unwind their risky positions as the market starts to make progress. Testing the market’s speculative voltage, volume on the S&P 500 (my favored benchmark for speculative appetites) slumped to its lowest level in two weeks with the three-month average for daily turnover slipped to a fresh 14-year low. Though we don’t have measures for the FX market, the ill-effects of tepid speculative liquidity is observed in the lack of meaningful trend development over the weeks and months.

In these hobbled conditions, capital markets and the dollar are still dependent on the balance between risk trends (which is supposed to be the sole measure of performance under normal conditions) and stimulus. The BoJ’s move this morning (adding 10 trillion yen to its efforts) more firmly characterizes recent efforts to bolster growth and ensure investor confidence as an unofficial, global coordination. With the Fed’s QE3, the ECB’s OMT program, the BoE’s Funds for Lending and now the BoJ following up; we have seen the world’s most prolific policy authorities stretch the limits of what they can offer. It is unlikely that they can leverage their effort in a meaningful way beyond what has already been put in place. So what happens if capital markets correct from in the near future - which is highly likely. The situation can become desperate.

Euro Tumbles Across the Board but EURUSD 1.3000 Primary Focus

Given the reserved level of market activity for the broader capital markets, the euro’s individual weakness stands out. The single currency fell against every one of its major counterparts pointing to an intrinsic weakness...a bearishness that generated more momentum than the broader markets seemed capable of. For EURUSD, the 0.5 percent drop may seem modest on a long-term scale; but this slide was the deepest for the pair since August 1.

From the fundamental backdrop, the fundamental decay has ate away at the currency since the details of the ECB’s new bond program were announced. A potentially unlimited stimulus program looks remarkable at first blush, but the heavy constraints of conditionality and the stigma of tapping stimulus programs (which hasn’t worked all that well for Greece) truly undermine the positive aspects to the effort. This past session, the Deputy Prime Minister said Spain could ask for a full bailout and tap the program if the conditions were right. However, ECB’s Coene was far more practical about the situation when he suggested Spanish yield would rise if they didn’t and essentially force them to seek assistance.

Japanese Yen: BoJ Adds Stimulus Cross Offer Slow Reaction

Japanese policy officials have played their cards and the market has little confidence in what can be achieved via more stimulus. The Bank of Japan followed the US and European central banks’ lead by announcing a 10 trillion yen increase to its asset purchase program (this time keeping its credit facility untouched), lifting the total to 80 trillion yen. Back in February, the announcement of an increase to the same program led to the most constructive advance for USDJPY in years; but a similar effort months later failed to do anything to the yen. The fact that other central banks moved earlier gives this particular move a little more validity. However, doubt over Japan’s stimulus impact is clear.

Australian Dollar Continues its Retreat with Others Falling in Line

AUDUSD was a standout Friday when it retreated from 1.06 resistance when other risk-sensitive assets (and dollar-based pairs) were pushing higher. As the pair continues its decline, it is picking up a few partners (like the Euro), which moves us closer to true validity in risk aversion. For now, risk trends are steady; yet the12-month RBA rate forecast has taken a steep dive (nearly 20bps) to supplement the sentiment shift.

British Pound Risks Reversal Below 1.6200 with BoE Minutes on Deck

After six consecutive weeks of advance into last weekend and a five-day run through Monday, GBPUSD has shown signs of leveling off. A bearish close Tuesday by the cable has curbed the ‘extreme’ reading before hitting April swing highs, but the levels are still extended. Retail traders recognize the potential with a -3.3 SSI reading. With risk trends still struggling to gain a footing, perhaps the BoE can decide a break.

New Zealand Dollar 2Q GDP on Deck after Key Says Government Can’t Hold Kiwi Down

Standing in direct contrast to the Euro, the New Zealand dollar showed bullish – albeit modest – progress against all of its benchmark counterparts this past trading session. It was therefore appropriate timing by Prime Minister Key to remark that the government cannot keep drive the currency lower permanent. He is one of the few in power that recognizes this. Meanwhile, 2Q GDP is on deck for volatility.

Gold Range Bound for Third Day, Breaking 1775 Requires Stimulus and 1750 Risk Trends

Despite the BoJ’s effort to add to the global stimulus effort, gold (the favored alternative to currencies and fiat assets) wasn’t able to overtake recent resistance at 1775. We are working on a fourth day of congestion above 1750. Given the rally that led into this recent consolidation, a breakout seems a high risk. But, if the market doesn’t leverage the anti-stimulus appeal of gold, it may succumb to a dollar rebound.

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--- Written by: John Kicklighter, Senior Currency Strategist for DailyFX.com

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